Budgets and Policies

Budgets are plans of action based on forecasted transactions, activities, and events that are synonymous with managing an organization. They are essential to accomplishing the goals articulated in an organization's strategic plan and are used to communicate information, coordinate activities and resource usage, motivate employees, and evaluate performance. The budgeting process provides the opportunity to match organizational goals with the resources necessary to accomplish those goals.

Budget policy development involves several distinct steps. This policy starts with an understanding of needs and issues, describes explicit policies governing the development and management of financial resources, identifies broad goals, sets objectives with which to apply available funding, and concludes with specific funding proposals. In assessing issues and needs, this policy builds on actions taken in previous budgets, thereby providing continuity with previous programs.

Based on the case (Hector Corporation) below please help formulate a respond to the following:

1. Comment in thorough detail on the Hector Corporation's policy.
2. In thorough detail, what changes should or could be recommended to the policy?

Policies for Budget Development:

Case 1: Hector Corporation is a manufacturing company with annual sales of $25 million. Its budget committee has created the following policy that the company uses each year in developing its master budget for the following calendar year:

May: The Company's controller and other members of the budget committee meet to discuss plans and objectives for next year. The controller conveys all relevant information from this meeting to division managers and department heads.

June: Division managers, department heads, and the controller meet to discuss the corporate plans and objectives for next year. They develop a timetable for developing next year's budget data.

July: Division managers and department heads develop budget data. The vice president of sales provides them with final sales estimates, and they complete monthly sales estimates for each product line.

August: Estimates of next year's monthly production activity and inventory levels are completed. Division managers and department heads communicate these estimates to the controller, who distributes them to other operating areas.

October: The budget committee meets to discuss the preliminary master budget and to make any necessary corrections, additions, or deletions. The controller incorporates all authorized changes into a final draft of the master budget.

November: The controller submits the final draft to the budget committee for approval. If the committee approves it, it is distributed to all corporate officers, division managers, and department heads.

Solution Preview

1. Hector Corporation policy has several weaknesses. First, the company's controller and other members of the budget committee meet to discuss plans and objectives for next year. The problem is that those objectives are very difficult to set without sales forecasts and inputs from production. Second, if the divisional managers and department heads develop budget data and use estimates given by the VP sales in July, then these estimates are likely to be inaccurate. Sales estimates change with changes in the economy, competitor activity, and changes in technology. Using July estimates can make Hector Corporation's budgeting inflexible. Based on July sales estimates, Hector Corporation develops a production plan and inventory levels. From the perspective of production, such a plan is very convenient but this budget does not give Hector Corporation any space to effectively respond to changes in the market and business environment. During September the operating areas submit their ...